ECON Chapter 17 Study Guide
Why did the Fed help JP Morgan Chase buy Bear Stearns?
A and C
The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model. If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06, we would expect the Federal Reserve Bank to pursue ________ monetary policy. If the Fed's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Actual real GDP _______. Potential real GDP _______. Price level _______. Unemployment _______.
A contractionary Decreases; does not change; decreases; increases
Which of the following is not one of the monetary policy goals of the Federal Reserve ("the Fed")?
A high foreign exchange rate of the U.S. dollar relative to other currencies.
What is a banking panic? Which of the following best explains how the Federal Reserve acts to help prevent banking panics?
A situation in which many banks experience runs at the same time. The Fed acts as a lender of last resort, making loans to banks so that they can pay off depositors.
In the figure to the right, when the money supply increased from MS1 to MS2, the equilibrium interest rate fell from 4% to 3%. Why?
All of the above
The hypothetical information in the following table shows what the situation will be in 2021 if the Fed does not use monetary policy. If the Fed wants to keep real GDP at its potential level in 2021, it should use _______ policy. Use the diagram to the right to illustrate the effects of this monetary policy action consistent with the data for the year 2021 in the table above.
An expansionary Picture 2
Consider the figures below and determine which is the best description of what causes the shift from AD1 to AD2.
Both A and B
Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates and, as a result, impacts aggregate demand?
Business investment projects, The value of the dollar, and Consumption of durable goods
If the Federal Open Market Committee (FOMC) decides to increase the money supply, it orders the trading desk at the Federal Reserve Bank of New York to If the FOMC orders the trading desk to sell Treasury securities,
Buy U.S. Treasury securities. The money supply curve will shift to the left, and the equilibrium interest rate will rise.
When the Federal Open Market Committee (FOMC) decides to increase the money supply, it _______ U.S. Treasury securities. If the FOMC wishes to decrease the money supply, it _______ U.S. Treasury securities.
Buys; sells
What is inflation targeting?
Committing the central bank to achieve an announced level of inflation.
In the figure to the right, the opportunity cost of holding money _______ when moving from Point A to Point B on the money demand curve.
Decreases
In the figure to the right, the opportunity cost of holding money when moving from Point A to Point B on the money demand curve.
Decreases
The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. We would expect the Fed to pursue what type of policy in order to move AD2 to AD2, policy and reach equilibrium (point C) in the second period? ________. If the Federal Reserve Bank's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP: ______ Potential real GDP: _______ Price level: _______ Unemployment: _______
Expansionary monetary policy Increases; does not change; increases; decreases
To affect economic variables such as real GDP or the price level, the monetary policy target the Federal Reserve has generally focused on is the
Federal funds rate.
The interest rate that banks charge each other for overnight loans is called the Which of the following statements is correct?
Federal funds rate. All of the above are true.
In 2017, one article in the Wall Street Journal had the headline: "Federal Reserve Expected to Deliver Rate Increase." What rate was the headline likely referring to? Who is able to borrow and lend at that rate? Why does the Fed's actions to increase or decrease the rate you identified above attract so much attention?
Federal funds rate. Banks are able to borrow and lend from each other at that rate. This rate ultimately has a substantial effect on many other interest rates.
An article in the New York Times in 1993 stated the following about Fed Chairman Alan Greenspan's decision to no longer announce targets for the money: "Since the late 1970's, the Federal Reserve has made many of its most important decisions by setting a specific target for growth in the money supply ... and often adjusted interest rates to meet them." If the Fed would no longer have a specific target for the money supply, it would be targeting the The Fed gave up targeting the money supply because
Federal funds rate. The relationship between monetary aggregates and other economic variables was becoming unreliable.
Since 1950, the annual inflation rate in the U.S.
Has typically been positive, but it has also varied substantially, peaking around 1980, and becoming negative for several months in early 2009 due to the effects of the Great Recession.
In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD1 to MD2 (Point A to Point C)?
Increase in real GDP or increase in the price level
Which of the following is a monetary policy target used by the Fed? The Fed uses policy targets of interest rate and/or money supply because
Interest rate. It can affect the interest rate and the money supply directly and these in turn can affect unemployment, GDP growth, and the price level.
How do investment banks differ from commercial banks?
Investment banks do not take deposits AND Investment banks generally do not lend to households
The federal funds rate
Is the rate that banks charge each other for short-term loans of excess reserves
What do economists mean by the demand for money? What is the advantage of holding money? What is the disadvantage of holding money?
It is the amount of money—currency and checking account deposits—that individuals hold. Money can be used to buy goods, services, or financial assets. Money, in the form of currency or checking account deposits, earns either no interest or a very low rate of interest.
Which of the following is NOT a monetary policy goal of the Federal Reserve bank (the Fed)?
Low prices
Consider the figure to the right. Can the Fed achieve a $900 billion money supply (MS) AND a 5% interest rate (point C)?
No. The Fed cannot target both the money supply and the interest rate simultaneously.
Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD2, policy and reach equilibrium (point C) in the second period? (What policy will increase the price level and increase actual real GDP?)
Open market purchase of government securities.
The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD2, policy and reach equilibrium (point C) in the second period?
Open market purchase of government securities.
The Fed's two new policy tools are The Fed now needs to rely on these two new policy tools to change the federal funds rate because
Paying interest on bank reserve holdings and paying interest on repurchase and reverse repurchase agreements. Banks were not loaning out excess reserves.
The graph shows equilibrium in the money market. The equilibrium interest rate is determined at point E where the money demand and money supply curves intersect. Suppose the Fed wants to lower the equilibrium interest rate.
Picture 1
What two institutions did Congress create in order to increase the availability of mortgages in a secondary market?
"Fannie Mae" and "Freddie Mac"
When interest rates on Treasury bills and other financial assets are low, the opportunity cost of holding money is _________, so the quantity of money demanded will be _________.
Low; high
In mid-2017, an article in the Wall Street Journal noted that: "The Federal Reserve's interest-rate increases aren't having the desired effect of cooling off Wall Street's hot streak...where stocks have rallied to records this year..." Is cooling off rapid increases in stock prices part of the Fed's dual mandate? Are such increases a concern for the Fed? Briefly explain.
No, this is not part of the Fed's dual mandate of price stability and high employment. Yes, rapidly rising stock prices could be a concern for the Fed because it has a goal of stable financial markets.
Suppose that when the Fed decreases the money supply, households and firms initially hold less money than they want to, relative to other financial assets. As a result, households and firms will _________ Treasury bills and other financial assets, thereby _________ their prices, and _________ their interest rates.
Sell; decreasing; increasing
When the Fed conducts monetary policy, the most relevant interest rate is the
Short-term nominal interest rate.
According to the Taylor rule, what is the federal funds target rate under the following conditions? follows ≻Equilibrium real federal funds rate equals 22% follows ≻Target rate of inflation equals 22% follows ≻Current inflation rate equals 11% follows ≻Real GDP is 11% below potential real GDP The federal funds target rate equals _______%.
2.0
If real GDP increases, If the price level decreases,
The money demand curve shifts to the right. The money demand curve shifts to the left.
Which of these variables are the main monetary policy targets of the Fed?
The money supply and the interest rate
One of the goals of the Federal Reserve is price stability. For the Fed to achieve this goal,
The rate of inflation should be low, such as 1% to 3%, and should be fairly consistent.
How can investment banks be subject to liquidity problems? Investment banks can be subject to liquidity problems because
They often borrow short term, sometimes as short as overnight, and invest the funds in longer-term investments.
In response to problems in financial markets and a slowing economy, the Federal Open Market Committee (FOMC) began lowering its target for the federal funds rate from 5.25 percent in September 2007. Over the next year, the FOMC cut its federal funds rate target in a series of steps. Writing in the New York Times, economist Steven Levitt observed, "The Fed has been pouring more money into the banking system by cutting the target federal funds rate to 0 to 0.25 percent in December 2008." What is the relationship between the federal funds rate falling and the money supply increasing? How does lowering the target for the federal funds rate "pour money" into the banking system?
To decrease the federal funds rate, the Fed must increase the money supply. To increase the money supply, the Fed buys bonds on the open market, which increases bank reserves.
When Congress established the Federal Reserve in 1913, its main responsibility was Congress broadened the Fed's responsibility since
To make discount loans to banks suffering from large withdrawals by depositors. The 1930s as a result of the Great Depression.
An article on Reuters discussing a Reserve Bank of India (RBI) monetary policy meeting in early 2017 stated that the RBI "changed its stance to 'neutral' from 'accommodative,' saying it would monitor inflation." The article noted that "the decision to hold [the interest rate that is the RBI's equivalent of the federal funds rate constant] is a risk, as private forecasts are more pessimistic [about economic growth] than the RBI." Draw a dynamic aggregate demand and aggregate supply graph to show where the RBI expected real GDP to be relative to potential GDP in 2017 if it kept its target interest unchanged. Assume, for simplicity, that real GDP in India in 2016 equaled potential GDP. Assume the economy is initially in long-run equilibrium at Briefly explain what is happening in your graph. If the target interest rate and the RBI's expectations are correct, then real GDP _______ potential GDP. Now, using the graph, show where the private forecasters who are more pessimistic about growth see the economy in 2017. Briefly explain what is happening in your graph. If the private forecasters are correct, then real GDP _______ potential GDP.
Picture 3 Equals Picture 4 Is less than
If the Federal Reserve is late to recognize a recession and implements an expansionary policy too late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the recession, the poor timing caused another problem: inflation. This is an example of what type of policy?
Procyclical policy
Consider the variables that shift money demand and money supply. Match each of the following scenarios with one of the four graphs of money demand and money supply. a. More widespread use of mobile wallets b. Fed decreases the required reserve ratio c. Fed sells Treasury securities d. Real GDP increases Figure A illustrates Figure B illustrates Figure C illustrates Figure D illustrates
Real GDP increases. The Fed selling Treasury securities. More widespread use of mobile wallets. The Fed decreasing the required reserve ratio.
Which one of the following is not one of the monetary policy goals of the Fed? Why is the Fed sometimes said to have a "dual mandate"? The Fed is said to have a" dual mandate" because
Reduce income inequality. Maintaining price stability and high employment are the two most important goals of the Fed.
With a __________, the Fed buys a security from a financial firm, which promises to buy it back from the Fed the next day.
Repurchase agreement
The ________ is considered the most relevant interest rate when conducting monetary policy.
Short-term nominal interest rate
A former Federal Reserve official argued that at the Fed, "the objectives of price stability and low long-term interest rates are essentially the same objective." This is true because
Stable prices make it easier to plan for the future, so expectations can be stable, which makes it less costly to make loans.
A column in the Wall Street Journal referred to policy actions aimed at "fulfilling both sides of the Fed's dual mandate." Which of the following gave the Fed a dual mandate? Does the Fed's dual mandate require it to attain a zero percent unemployment rate? Briefly explain. Does the Fed's dual mandate require it to attain a zero percent inflation rate? Briefly explain.
The Employment Act of 1946. No, because even when the economy is at full employment, there is still a natural rate of unemployment. No, because price stability is sufficient.
The Fed uses monetary policy to offset the effects of a recession (high unemployment and falling prices when actual real GDP falls short of potential GDP) and the effects of rapid expansion (high prices and wages). Can the Fed, therefore, eliminate recessions?
The Fed can only soften the magnitude of recessions, not eliminate them.
In the graph of the money market shown on the right, what could cause the money supply curve to shift from MS1 to MS2? In the graph of the money market shown on the right, what could cause the money demand curve to shift from MD1 to MD2?
The Fed decreases the money supply by deciding to sell U.S. Treasury securities. Both (a) and (c).
Nobel laureate Milton Friedman and his followers belong to a school of thought known as monetarism. What do the monetarists argue the Fed should target?
The Fed should target the money supply, not the interest rate, and that it should adopt the monetary growth rule.
In response to the severity of the financial crisis, the Fed started to rapidly reduce the target range for the federal funds rate in September 2007 and, from December 2008 to December 2015, held the target range between 0% and 0.25%. Which of the following statements is true?
The Fed successfully held the actual federal funds rate within that target range over the seven-year period by conducting open market operations to increase or decrease bank reserves quickly.
Consider the following table: What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of long-run macroeconomic equilibrium? If the Fed's policy is successful, what is the effect on the following indicators? Actual real GDP: ______ Potential real GDP: _______ Price level: _______ Unemployment: _______
The Fed will pursue an expansionary monetary policy. Increases; does not change; increases; decreases
As the figure to the right indicates, the Fed can affect both the money supply and interest rates. However, in recent years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed target?
The federal funds rate
The federal funds rate is Additionally, the federal funds rate is
The interest rate that banks charge each other for overnight loans. Very important for the Fed's monetary policy because the Fed uses the federal funds rate as a monetary policy target since it can control the rate through open market operations.
